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07/09/2009 | G20 Finance Ministers Make Progress on Financial Sector Reform But Light on Specifics

Global Insight Staff

Finance ministers emerged from the latest G20 meeting upbeat over global economic recovery, and about the potential for a broad agreement on banking sector reform; however, behind the scenes, it is clear vigorous debates continue.

 

IHS Global Insight Perspective

 

Significance: Throughout the global economic crisis leading governments have endeavoured to present a unified front, but in reality policy co-ordination has been limited and divisions have often been visible between continental European governments and those of the United States and United Kingdom.

Implications: The latest meeting in the U.K. capital, London, saw welcome talk of consensus, but the announcements were light on specifics. Banking reform discussions focused on balance-sheet standards and on how far to rein in bonuses.

Outlook: Whether the finance ministers have laid the ground for a far-reaching reform agreement will become clearer in the build-up to the G20 summit in Pittsburgh (United States) on 24–25 September.

Seizing the Opportunity?

The global economic crisis has spurred unprecedented international momentum behind financial sector reform. Leading countries are pushing ahead with ambitious plans, acknowledging that lax regulatory environments encouraged unacceptable risk-taking and a lending bubble that exploded spectacularly. One major hurdle, however, is the need for competing financial centres to enact similar reforms and ensure that the competitive landscape is not skewed. This was the major preoccupation for G20 finance ministers when they assembled in the British capital at the end of last week. The meeting was not expected to produce firm agreements, but it was a test of how close governments are to consensus. The danger from the perspective of reform advocates is that tentative economic recovery and improved banking stability will lead to complacency and erode the reform momentum built at the depth of the crisis.

On the face of it, the meeting was a success. There was broad agreement on reining in the bonus culture among banks, as well as on tighter balance-sheet requirements for the institutions. The devil is in the details, however—can the broad agreements be translated into specific measures in time for the September G20 summit? Dominique Strauss-Kahn of the International Monetary Fund (IMF) acknowledged this challenge: "I'm impressed by the level of consensus, but I'm still waiting for strong measures to be decided and also to be implemented at the national level".

Bonuses

On the question of bankers' bonuses it is clear that all the governments share distaste for a system that arguably ran out of control, encouraging short-termist risk-taking and leaving collapsing banks with huge financial liabilities. There are, however, differences over how practical it is to regulate bonuses, and whether governments are enmeshing themselves too deeply in corporate decision-making. The London meeting produced a set of guidelines governing bonuses, but it did not agree a set cap as France would have liked. The Financial Stability Board, a group of international regulators, has been asked to consider whether a limit on the total bonus payments made by individual banks as a share of profits is warranted. The guidelines meanwhile call for a large portion of bonuses to be retrievable if the bank's performance deteriorates. How the deferral and clawback processes would work is unclear, however. There would also be greater disclosure over the compensation of top traders. It should be noted that a number of leading banks (including the United Kingdom's RBS) have already adjusted their compensation programmes along the lines of what governments are proposing. Germany and France have been the strongest advocates of tough measures on bonuses.

Capital Adequacy

In terms of strengthening banks' capital bases—an issue that the United Kingdom and United States argue is more important than bonuses—there was agreement on broad principles, but the questions of implementation and enforcement were left open. Governments will continue to negotiate on what the new capital requirements should be. The United States is pushing for agreement by the end of 2010, with entry into force two years later. The United States has lately been pushing for international banks to introduce a leverage cap—a minimum ratio of capital to assets. This is a traditional measure in U.S. banks, but in Europe the focus has instead been on capital ratios against risk-weighted assets. This means different requirements according to the perceived risk of different asset types. Any final agreement is likely to include both, with the leverage cap used as a fallback.

In the run-up to the London meeting, the European Commission highlighted its major area of concern regarding capital requirements. At a conference in Brussels (Belgium) on 3 September, Internal Market Commissioner Charlie McCreevy said that the European Union (EU) wanted to introduce "specific and penal" capital requirements on banks to prevent excessive lending in foreign currencies. Loans to households denominated in currencies other than that of the borrower’s income had become a major concern for regulators, threatening to spill instability amongst foreign-owned banks in Eastern Europe over to parent banks in Western Europe. This has already caused substantial disruption to financial markets in Austria, Ireland, and Germany, amongst others, where government-sponsored bank recapitalisation programmes have cost many billions of euro. One of the principal causes of this disruption is seen as the high volumes of foreign currency lending to individual borrowers in Eastern Europe, who have been attracted by lower interest rates on loans in Swiss francs and euro, but who have not been made sufficiently aware of the exchange risks. Banks in some countries, notably Hungary, have belatedly attempted to reduce this type of lending as the risks have begun to outweigh the benefits, while Ukraine (not an EU member) has introduced legislation to prohibit such loans altogether. EU regulators believe that actions taken in individual countries are not enough to contain the crisis, and have proposed stricter capital requirements, including 100% risk weighting for mortgage loans with a loan-to-value ratio of 100% or higher (compared with the normal weighting for mortgage loans of between 30% and 50%).

Outlook and Implications

Although it is clear that there remain differences in emphasis between key governments, the London meeting shows that there is still international momentum behind co-ordinated financial reforms. Without agreement on broad principles, the prospects of individual governments taking bold steps that could undermine the competitiveness of their financial sectors would be limited. Coming weeks will be critical as the bones are fleshed out and a more concrete agreement is prepared for the Pittsburgh summit.

Turning briefly to the wider economic picture, the finance ministers allowed themselves some cautious pats on the back at the meeting as they discussed the promising signs of recovery. The bold monetary and fiscal stimulus policies they introduced have undoubtedly helped bring this about, although this masks their repeated failures to agree closely co-ordinated measures. Stimulus was instead largely carried out on a piecemeal national level, with some governments moving faster and more vigorously than others.

At the meeting the ministers pledged to maintain policies designed to support economic growth, but did not give any details as to when they would see fit to start unwinding them. This is indeed the big question—when will central banks see fit to raise interest rates above their historic lows, for example? It seems it will be up to key governments such as the United States to set precedents unilaterally when they feel the time is right. Certainly, recent statements from monetary policy authorities have suggested that the unwinding is still some time off, lest nascent recovery is jeopardised. Some finance ministers at the meeting—including Brazil's—warned that a double-dip recession was still possible. Germany has by contrast been the most vociferous advocate of developing exit strategies, but even it is opposed to setting any timetable at this stage.

Global Insight (Reino Unido)

 


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